Where Does Cash-Rich American Airlines Go From Here?

| About: American Airlines (AAL)

On Friday, American Airlines Group (NASDAQ:AAL) announced that it has about $10.3 billion in cash and highly-liquid short term investments. Given that the company's current market cap is at $22.39 billion, the company is trading a little more than two times its cash holdings and it is still highly profitable. Usually, when we think about the companies which trade at levels close to their cash holdings, we see companies that are not profitable and losing money, and people are wondering whether these companies will even survive to see tomorrow. Profitable companies like American Airlines usually trade for far above the book value, especially at this time when almost the entire market enjoys rich valuations.

In the last few years, airline companies achieved strong margins due to elimination of routes that are not very profitable, reducing their leverage on volatile oil prices, increasing their ticket prices when the demand is hot, negotiating new deals with existing employees and the unions representing them, buying new planes that are more fuel-efficient than their older planes and consolidating by merging with other airlines. Prior to the merger, US Airways (LCC) increased its profitability and net profits by nearly 300% and American Airlines was getting highly profitable following the company's bankruptcy.

Currently, many large airline companies enjoy historically high load factors (the ratio of total seats to booked-seats per mile traveled), and air travel is getting more popular. If this trend continues, the sky will be the limit for the airline companies (no pun intended). At the current rate, passenger traffic seems to increase in mid-single digit percentage year-to-year and Americans spend more on each ticket they purchase compared to the previous year. In fact, ticket prices went up for 4 years in a row while the number of passengers also rose simultaneously.

According to the last update of the company, it expects to spend between $3.00 and $3.11 per gallon of mainline jet fuel. The US Airways part of the company is expected to spend about 10 cents less per gallon compared to American Airlines due to its practice of not hedging.

Since the debtholders of the previous American Airlines (AAMRQ) became the shareholders of the new company, the debt of the new company will mostly consist of the debt of US Airways, which was around $5.5 billion prior to the merger.

Currently, we don't know the exact book value of the new American Airlines but we will know it once the company announces its quarterly earnings. We know that the company's assets will shrink a little bit because the Department of Justice asked it to reduce some of its take-off and landing spots in an effort to prevent the company from becoming "too big" as a part of a settlement that was reached late last year. For example, in the nation's capital, American Airlines Group will lose 104 take-off spots.

Last year was a highly profitable year for both US Airways and American Airlines, and the two companies are expecting to achieve about $1 billion in synergy as a result of the merger, which means that the profitability of the merged company should be about $1 billion more than the sum of two companies. For the entire year of 2014, the analysts expect American Airlines Group to generate $42.30 billion in revenues and $3.52 per share in net income, with estimates ranging from $2.60 to $5.03 per share. By 2015, the company is expected to earn about $4.01 per share as a result of the synergies due to the merger. By 2015, American Airlines Group will have a P/E ratio of 4.14 excluding its cash and short term investments. I understand that most airline companies trade for low P/E ratios due to the high risk nature of the industry, a history of bankruptcies and cyclicity of airline companies; however, we are passing through a time when airline companies are living their golden age. This is a time when many airline companies are bigger, stronger, more profitable and the future for them looks brighter than any time in history. Through the past bankruptcies and lack of profitability, airline companies learned a lot of lessons and they learned how not to repeat the mistakes of the past.

If American Airlines Group can continue on its path of being strongly profitable, use its profits to pay off its debt, keep improving its balance sheet and convince the investors that it is here to stay, I don't see why it shouldn't double in market value in a few years. Once things get stable, I can also see the company buying back shares in large numbers in order to increase the value for the investors. The company had to issue 746 million shares as a result of the merger in order to pay off the debtholders of the old American Airlines and the current share count is pretty high. Reducing the share count of the company should probably be one of the first priorities of the management once the dust settles.

Disclosure: I am long AAL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.